Perspectives on where our world is heading from a vantage point in Denver, Colorado.

03 September 2007

How Do Economies Develop?

Standard economic theory is a poor predictor of how economies develop. This appears to be largely because it has failed to recognized how particularized the infrastructure and skills associated with many forms of economic endeavor are, and hence, how tight a fit new economic activities that build on that basis must have with existing economic activities to usefully transfer that productive culture.

Empirical evidence from the last couple of decades of export data indicates that an economy mostly develops by expanding into industries that require extremely similar infrastructure and skill bases to existing products (e.g. from one kind of garments to lingere, or from electronics to cameras). Many of the industries that turn out to have similar requirements (e.g. fish exports and produce exports) are not terribly intuitive, and some industries have much more portable requirements than others.

[P]roducts tightly connected to each other . . . include the vast majority of industrial products, from machinery and steel to chemicals. Garments, textiles, and electronics form their own, smaller, clusters. . . . [A]lmost in isolation . . . are products such as oil, minerals, cereals, and coffee. . . . Fast-growing developing countries such as China, Thailand, and Hungary are strong in some of those central, well-connected [products]. The poorest countries, especially those in sub-Saharan Africa, tend to specialize in a few of the peripheral products—such as oil for Nigeria and copper for Zambia.

This helps explains conundrums such as why resource poor countries like Israel and Japan have proved far more successful at economic development, than resource rich countries. Natural resource based economies tend to have industry specific economies that don't easily translate to economic activity in other sectors. Resource poor economies, in contrast, have no choice but to develop economies in areas that are more easily generalized.